How are Defense Costs in a D&O Policy handled?

When you purchase a management or professional liability policy, such as a D&O, E&O, or Employment Practice Liability policy there is an issue regarding the defense of future claims and how they will be handled.

Duty to Defend

The first method is that the policy explicitly says that the insurer has the duty and obligation to provide the insured defense in the event of a claim. This is of course known as a “duty to defend” policy form. It is common in the small business marketplace and the non-profit market.

It is convenient and simple.

You have a claim or believe you have a situation that may give rise to a claim and you report it to your insurer. The insurance company will assign an attorney from their panel counsel list to your claim and off you go.

The other defense clause or method by which insurers handle the defense of claims is a non-duty to defend or reimbursement type policy form, also known as an indemnity policy. Reimbursement or indemnity type policy forms are common in the public company D&O market as well as larger middle market type account markets.

What is a Reimbursement Form? What’s in it?

Under a reimbursement or indemnity form, as its name indicates, the insured has the duty to defend themselves in a claim and their insurer will reimburse the insured for the sums spent more than the retention or deductible.

Now a separate issue regarding defense costs to be aware of is whether a defense is included within the limits of liability or outside the limits of liability.

In most general liability policies and business auto liability policies defense is provided outside the limits of liability. Meaning that if your policy has a $1,000,000 limit of liability, the insurance company will spend whatever they need to defend you in a claim and the entire $1M limit of liability is preserved for actually paying the claim.

On the other hand, most management and professional liability policies act conversely. Meaning that whatever sums you or your insurer spend on defense are made part of the limit of liability and eat away at your limits of coverage. There are some variations of this, but say you have an Employment Practice Liability policy with a limit of $1,000,000 and you’re firm is hit with a claim – say a sexual harassment claim from multiple plaintiffs – your defense costs could skyrocket. Every dollar spent on defense is one less dollar available to pay potential settlements. As defense costs stack up, they absorb the available limits left to pay eventual or potential settlements.

This is why in management and professional policies it’s important to consider higher limits of liability than just $1M. Sure, if you’re a small firm with less than 10 employees a $1M limit MAY be sufficient (it may not be) but over 10 employees you should consider higher limits than $1M when buying D&O, E&O, Employment Practice Liability, Cyber and other forms of management and professional liability.

I recommend when first buying coverage and at every renewal that you ask for options. If you’ve purchased management or professional policy in the past at $1M limits, ask to see options of $2M and $3M and see if your budget can afford to move limits up.

Lawsuits are not getting less expensive to defend against and neither are settlements. Costs continue to go up, and your limits of protection should address these increasing costs.

The final point when it comes to Defense Costs and Limits.

Management and professional policies also have an aggregate limit of liability in addition to the per claim limit of liability. Commonly, the aggregate limit will equal the per claim limit.

The aggregate limit is the most your policy will pay for all claims during the policy term. So, as an example, you have a $1M limit of liability and have a claim that racks up $750,000 in legal defense costs and settlement costs will mean that you’re policy only has $250,000 left to pay any new claim costs during that policy term.

This is another reason for higher limits and looking at limit options when first purchasing coverage or renewing it.

I hope that answers the question how are defense costs handled in a D&O policy, but if I missed anything, please let me know.

Have other questions regarding D&O, E&O or other management or professional liability coverages?   Why not click the button below and let’s get started on chatting.  I work with businesses all across the U.S. and love helping business owners with their difficult risk and insurance issues.

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